Dear Reader,

Today I have a small conspiracy theory in the financial world for you to think about. One of our readers, Dennis, recently wrote in asking if a rogue trader such as the one at UBS would have been treated differently had his rogue activities been profitable.

From what I know of risk-management departments, traders are punished for making unauthorized trades rather quickly. Usually they are caught by the end of the day. Hence, there isn’t time for the trader to earn billions. Even if his rogue activity paid off, he probably hasn’t put the company so far in the black that a manager would feel awkward about punishing him. After all, there’s a human element at play here. Punishing a rogue trader for a $2-billion loss and a $2-billion gain is technically the same thing, but it sure doesn’t feel the same.

According to an insider friend, rogue activity happens more often than one would think. However, stories of a single-day rogue trader never make it to the news. I don’t have any numbers on the frequency of these occurrences, but if it has happened even once, that’s enough. Now here’s the conundrum with Kweku Adoboli, the UBS rogue, and the other infamous rogue traders: Where are the profitable rogue traders?

Check out the list of big rogue trading scandals on Wikipedia. There’s not a single case of a profitable rogue trader, and I can’t think of any examples either. A Google search of the topic reveals nothing as well. If any of you readers know of a profitable rogue trader story out there, please send it in; I’d love to read and share it. Some rogue traders were initially profitable, but they eventually hit major losses. This is all rather odd. After all, there’s a lot of chance involved in markets. Simply by luck, a profitable rogue trader should exist somewhere. If all of our subscribers started picking random stocks, a bunch will come out winners by chance alone. So where are the winning rogues; and what explains the dominance of the losers?

Here are a few theories to consider, as well as counterarguments:

1. It’s a conspiracy. The banks are only reporting the losers while brushing aside the winners. Perhaps this is possible. I’d really have to know more about the auditing process for trading operations to know for sure. However, if a losing rogue can go unnoticed then surely a profitable rogue can do the same. By probability alone, the presence of only losers seems suspicious. It could only be explained by the banks covering up the rogue winners.

But then again, would a rogue winner be such disastrous news? Imagine that you’re a shareholder of a major bank. The company announces the presence of a $2-billion profitable rogue trader. On one hand, I’d be a little angry at the risk management department, but on the other, I would appreciate the honesty. In a world of opaque banks, that’s a valuable characteristic to possess. Plus the $2 billion is nice.

2. There’s a self-selection process happening here. Let’s face it, being a rogue trader is pretty damn stupid. If one is a trader for a major bank, that’s a good enough job. And if one is a good trader, there should be no reason to cheat the system. As a result, rogue traders are probably never the best traders in the department, nor even average performers. Instead, the folks with the biggest incentives to go rogue are the worst traders. They’re the ones who couldn’t make it by trading within their defined roles.

There’s definitely some evidence of this among several rogues. Their decisions in the market often leave one scratching one’s head. Not only is their rogue behavior incredibly stupid, but often their trades are as well. We don’t have all the specifics on the UBS rogue trader case, but we know that he was trading the Swiss franc/ US dollar pair. When the Swiss National Bank sought to devalue the franc by intervening in the market, Kweku Adoboli was caught with his pants down. On the one hand, this could happen to anyone. On the other hand, what kind of leverage was he using to produce an over $2-billion loss? I’ll tell you what kind of leverage. A stupid level of leverage. Had a smarter trader gone rogue, I doubt the losses would have been as big. Adoboli’s official role was to hedge risk. I can’t think of better evidence to prove that he was horrible at this job.

However, even this view holds some problems. A trader might be stupid, but he was obviously smart enough to outfox risk management. Are rogue traders masters of deception but fools in the market?

3. My third explanation is another case of self-selection in the group, but this time regarding risk. Even if the trader is a pretty smart guy, he has crossed a serious risk threshold by engaging in rogue activity. As a result, he will probably trade the markets in a risky way as well. And it doesn’t take a genius to figure out what happens with extraordinary risks in the marketplace – more often than not, they lead to busts. However, this explanation doesn’t completely hold up to the criticisms of point number one. Sure, taking excessive risks is a good way to go bankrupt, but sometimes big risks do pay off.

So, what’s my conclusion? I’m not sure; these are all possible explanations. Write in and let me know what you think. For now, we just have big losers among rogue traders. If there’s ever a $2-billion profitable rogue trader, I’m going to love to see the media circus over that. The guy might receive jail sentences and job offers on the same day.

First up today, Louis James will give us some notes from the field, this time from the Yukon. Though mining development has been slow in the last decade, it could begin to pick up. Then Doug Hornig discusses some libertarian dreams on the way to becoming reality.

Notes from the Field: Yukon

By Louis James

I’ve just returned from another trip to the Yukon. Details on the companies I saw I’ll have to keep for Casey International Speculator subscribers, but there is a broader observation I can share that I think is of value.

The Yukon has a long and famous history of exploration and mining – especially for gold – but currently there’s been little actual mining going on in recent years. Capstone Mining’s (T.CS) Minto mine was the first new hardrock mine built in the Yukon this millennium, with first concentrates shipped in 2007. Until Minto proved it could be done, the prevailing wisdom seemed to be that the Yukon was geologically interesting, but a remote and expensive place to work, as well as a difficult political environment that made the effort questionable. The success at Minto attracted a lot of exploration dollars, with Underworld Resources making a new discovery that was quickly snapped up by major gold miner Kinross Gold (KGC, T.K) in March of 2010. This really put the place high up on the radar screen, and exploration dollars flooded in.

However, a couple of months later, Western Copper (WRN, T.WRN) was delivered a surprise setback when the final permit it needed for its Carmacks copper project was rejected by the Yukon Water Board. This decision is being appealed, but the company is also seeking to address the regulators’ concerns, hoping to finally get the project permitted one way or the other. This has not slowed exploration in the territory, but it does have people wondering if the Yukon is really such a great jurisdiction for mining after all.

One answer to this is that Alexco Mining (AXU, T.AXR) was able – post-Camracks – to permit its Bellekeno mine in the Keno Hills district of the Yukon; it just went into commercial production. Now, Bellekeno has a much smaller footprint, being a high-grade underground mine with ore milled in a plant, rather than Carmacks’ heap-leach operation that would be the size of a mountain (sprinkled with scary-sounding chemicals), so it was much easier to permit, but it still shows that the government is not opposed to mining.

Well, not opposed so far; there is an election coming up, and it seems too close to call.

However, while my plane was grounded in Whitehorse due to weather, I bumped into a consultant who has worked with both the regulators and the mining industry. We had, I believe, a very sincere conversation (on that day, I was there to see another company, not hers) and she explained to me that the permitting process actually changed during the efforts to permit Carmacks. She also told me that, unlike British Columbia, most of the First Nations land claims have been settled in the Yukon, so dealing with native populations is much simpler. That’s a great advantage that removes a lot of uncertainty. Also, the Yukon being a relatively small territory with the government concentrated in Whitehorse, the actual logistics of dealing with regulators are simpler, and there’s less turf conflict between regulators. There was and always is a lot of politics involved in such things, but her take is that the Yukon is definitely a place where miners can work.

This perception fits with information I’ve gathered over the years from other sources. Permitting is always a challenge everywhere, but I think the average Yukoner wants to see the territory benefit economically from responsible mining. And the rocks sure look good. I think we’ll see more discoveries coming from the Yukon soon and more mines being built. I’ll be looking for more opportunities to profit if I’m right… and I’m looking now, while prices are down.

[Louis circles the world, applying Doug Casey’s 8 Ps to promising companies so that only the best speculative plays are recommended in Casey International Speculator. You can put his expertise to work for you: a trial subscription is completely risk-free for ninety days.]

Libertarian Dreams

By Doug Hornig

Peter Thiel obviously has keen business instincts and an impeccable entrepreneurial résumé. The cofounder of PayPal and one of Facebook’s earliest financial backers, he now manages a hedge fund, is a founding partner in a venture-capital firm, invests in music and movies, and has seed money in any number of Silicon Valley startups. So why is this guy throwing $1.25 million of his dollars at a libertarian pipe dream?

Okay, one reason is that he can. A mil and a quarter isn’t much to a billionaire. But more important is that this is a dream Thiel believes in.

Thiel’s donation is seed money for the Seasteading Institute, which is pursuing an enterprise that many consider too bizarre to ever succeed: the creation of micronations. In its own words, the Institute’s mission is to “further the establishment and growth of permanent, autonomous ocean communities, enabling innovation with new political and social systems.” The communities would be built on oil-rig-type platforms, anchored in international waters,

and thus not be subject to the rules and regulations of any other nation.

Seasteading, founded in 2008, is the brainchild of former Google engineer Patri Friedman (Milton’s grandson). “The ultimate goal,” he says, “is to open a frontier for experimenting with new ideas for government.” Most especially including the free market system championed by granddad.

Currently, the Institute’s “focus is on enabling the success of the first seasteads by researching the critical engineering, legal, and business problems, increasing public awareness, and building a core seasteading community.”

And its vision extends beyond just building a floating city dedicated to free enterprise. Each of the communities will be autonomous, with inhabitants encouraged to test out their own particular ideas for governance. The hope is that successes will inspire governments around the world to emulate the seasteads.

The Institute recognizes that it may take a while for the concept to catch on, but believes that the economic enticements for individuals and businesses to set up shop on seasteads will be irresistible once their feasibility is demonstrated. The tipping point is projected to arrive when there develops a strong market for seastead real estate, inducing developers to build more and more of them.

Seasteading is a laudable project, and we hope it succeeds. Meanwhile, back on land, additional free-market sentiments are stirring in the most unlikely of places.

Honduras is, after Haiti, the most impoverished nation in the northern hemisphere. Its economic destitution might seem intractable, and many of its citizens apparently agree with that judgment; 100,000 of them leave each year. But perhaps the country’s dire situation is what has pushed the government to propose a radical fix that resembles the plan of the San Francisco seasteaders.

The idea was inspired by the work of American economist Paul Romer, who has been proselytizing for “charter cities” modeled on Hong Kong, as a way to help nations out of poverty. Honduras bought into the notion, surely swayed by a speech Romer gave there, in which he preached the benefits that would result from the creation of Special Development Regions (“REDs” in Spanish).

Romer predicted that ten years after the creation of the first RED, the Honduran economy will be growing at a rate of 7%-8% annually, and that in twenty years the per-capita income of those working in the RED zones could reach US$32,000, about fifteen times higher than today. “Directly or indirectly, in 10 years all Hondurans who want to work will be able to do so,” Romer said.

Although it’s a vast undertaking, the basic idea is simple: take an uninhabited area and build a new city from the ground up. While keeping the city under the country’s general governance, let it have its own laws – ones that highly encourage investment and job creation and open the door to domestic or foreign entrepreneurs willing to locate there.

And so they’re going to give it a try. In January, the Honduran Congress amended the country’s constitution to permit REDs and then, in late July, passed a law to regulate these new entities. The government is now examining four regions of approximately 1,000 square kilometers each to determine which of them will be the site of the first “Honduran Hong Kong.” It is expected that work on the infrastructure will begin by the middle of next year and that there will be a fully functioning city on site in 2020.

According to President of the National Congress Juan Orlando Hernández, “Under this special legal regime the immediate result will be a massive amount of employment, due to the need to build highways, ports, airports and all the infrastructure facilities of the companies to come.”

During the early years, the construction jobs are projected to give opportunities to people with low qualifications, as in the model cities in Asia. “These towns offer employment opportunities for unskilled labor, who then gradually move to become part of the middle class or beyond,” says Minister of the Presidential Staff Octavio Sánchez. “In countries that have adopted similar models to this, rapid growth can be clearly seen.”

The question of course is: Who’s going to pay for this?

Answer: Outside investors.

Hernandez says there has been a great deal of corporate interest, and he names the Goldman Sachs Foundation and the Abu Dhabi Development Bank in particular.

It all sounds a little pipe-dreamy, and maybe it is. Even discussing the possibility that stone-broke Honduras could turn into a powerful engine of economic growth will no doubt get one some looks that say, “Uh oh, the loon has landed.” But who knows? It’d be something if Honduras became a model for our own broken economy to follow, wouldn’t it?

Friday Funnies

Here are a few choice images from FAIL Blog:

The Gulf of Mexico aquarium exhibit – how it used to look, thanks to our friends at BP.

Greatest employees? Maybe. Greatest spellers? Definitely not.

And we wonder why they’re out-competing us.

Finally, an honest bank! Where do I sign up?

This is a bit of an inside joke. To catch up those who need it: Cthulhu is a fictional octopus-like creature of pure evil from the works of H.P. Lovecraft, an early 20^th-century father of modern horror books.

That’s it for today. Thank you for reading and subscribing to Casey Daily Dispatch.

Vedran Vuk
Casey Daily Dispatch Editor